A recent Brookings Institution study points out that “even before the COVID-19 crisis, housing affordability and instability were serious problems.” The study outlines a number of goals and strategies for increasing the supply of affordable housing, including federal subsidies, low-cost loans, and grants. These may well be viable solutions, but what is missing are policies that make it less costly for developers to build and operate rental housing. Lawmakers can do that immediately by improving the taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. treatment of residential housing.
Building a multifamily apartment building can be quite costly. Construction costs alone can run between $64,000 and $86,000 per unit and don’t include other costs such as acquiring the land, architect fees, regulatory compliance, and permitting. After spending potentially millions of dollars to build a residential building or complex, the tax code requires developers to depreciate, or write off, the cost of that investment over 27.5 years. By contrast other businesses can fully write off their investments in equipment, like computers or delivery vans, in the year they were made.
Not only does it take nearly three decades to fully recoup those expenses, but the value of a dollar in 27.5 years is not equal to the value of a dollar today. By some estimates, the present value of deducting, for example, a $10 million residential building over 27.5 years is only worth 55 percent of the original investment, or $5.5 million.
One way of restoring the full value of writing off the cost of residential construction is to index the depreciationDepreciation is a measurement of the “useful life” of a business asset, such as machinery or a factory, to determine the multiyear period over which the cost of that asset can be deducted from taxable income. Instead of allowing businesses to deduct the cost of investments immediately (i.e., full expensing), depreciation requires deductions to be taken over time, reducing their value and discouraging investment. schedules by just enough to offset their decline in value over time. This type of indexing is known as neutral cost recoveryCost recovery is the ability of businesses to recover (deduct) the costs of their investments. It plays an important role in defining a business’ tax base and can impact investment decisions. When businesses cannot fully deduct capital expenditures, they spend less on capital, which reduces worker’s productivity and wages. .
According to the Tax Foundation’s General Equilibrium Tax Model, indexing these long-term residential investments in this way could reduce construction costs by 11 percent, which, in turn, would make more lower-rent apartments profitable to develop. In other words, under neutral cost recovery a developer would only need to earn about 89 percent of what they would currently charge in rent to cover their costs.
In addition to lowering the cost of constructing residential buildings and likely increasing their supply, there are wider economic benefits to improving the tax treatment of these investments. The Tax Foundation’s model also shows that providing neutral cost recovery to residential structures would increase the long-run level of GDP by 0.7 percent, increase wages by 0.6 percent, and create more than 136,000 full-time equivalent jobs.
Private business stocks (equipment, structures, etc.)
Full-time Equivalent Jobs
Source: Tax Foundation General Equilibrium Model, November 2019
Any federal response to the affordable housing shortage must address the underlying tax penalties for constructing residential housing. Failing to do so simply means that the cost of federal subsidies, grants, and loans must be greater to compensate for the poor tax treatment—and, thus higher building costs—of new residential projects.
In other words, by updating the tax code to allow developers to more fully cover their investments, construction costs will fall, which, in turn, means that federal assistance dollars will go that much further in helping low-income tenants. And since the increased investment in residential buildings will also increase GDP, wages, and jobs, it means that the benefits of the improved tax policy will be broadly shared.
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